More debt will not solve the world’s problems
By Dr Bharat Jhunjhunwala
The clouds of global recession are becoming darker. Reason is that governments of the developed countries have got used to spending more than their incomes. Most developed-country governments are running huge budget deficits. They are borrowing heavily to meet the gap. Such borrowing is justified if it is used to overcome a short-run problem.
For example, Japan would be justified to borrow to manage the loss due to the nuclear disaster. Future incomes earned from the investments could be used to repay the loans just as a company takes a ‘Bridge Loan’ to manage short term problems. But such borrowing is a curse if use of the money does not lead to additional incomes. The debt grows and interest burden mounts, but no additional income is forthcoming to repay the debt. Presently most developed-country governments are borrowing to meet their already committed excess expenditures. The borrowings are not used to generate additional productive assets like highways and ports that could generate additional income. The debt is mounting. This has led to the US Treasury Bonds being downgraded about two months ago. Banks in France and sovereign debt of Italy has recently been downgraded.
Developed-country governments have no clue as to how to solve this problem. They are thinking that somehow their incomes will increase and they will be able to repay the debt. But incomes show no sign of increasing. On the other hand, they are not able to reduce their expenditures because of people’s resistance. President Obama, for example, has reached an agreement with the Congress to cut government expenditures. But these cuts will start only after two years. Till then the present policy of borrow-and-spend will continue unabated. The point is that there is no will in the developed countries to acknowledge the writing on the wall and take harsh measures to cut expenditures and standard of living of their people immediately.
The debt of the US Government has been increasing exponentially. The debt increased by about $200 billion per year during 1997-2002. It increased by about $500 billion per year during 2002-08 and further by $1.6 trillion per year during 2008-11. The US debt will increase by $16 trillion in the next ten years if the present trend continues. The reduction in expenditures of $2.5 trillion agreed by President Obama and the Congress is small in comparison. The debt will yet increase by about $13.5 trillion even after the proposed reductions are made. It is obvious that the agreement will scarcely help solve the debt problem.
The basic problem is that revenues of the US Government are less and expenditures are more. First reason for this is absence of new commercially viable technological inventions. US companies made huge profits in the last sixty years after World War II from selling frontline products like jet airplanes and Windows software and American companies paid huge taxes to the Government from these incomes. They are paying fewer taxes nowadays in absence of such innovative products. Second reason for fewer revenues of the Government is that American companies have started producing goods abroad, thanks to globalisation. Ford Motor Company and General Motors, for example, are producing cars in India. Reduced production in the US means fewer taxes paid at home. Third reason is increased expenditures on wars in Iraq and Afghanistan. Although President Obama has resolved to bring back the troops from Afghanistan but the huge military expenditures will only escalate given the arms race with China and other emerging countries.
The agreement reached between President Obama and the Congress deals with this problem only very superficially. There is nothing in the agreement that would make the goods produced in the US competitive in the global markets. There is nothing that helps promote technological innovation. There is nothing which can lead to reduction in wages which would reduce the cost of production of goods. There is nothing about reducing war expenditures. In fact, the agreement distracts attention from these fundamental problems by creating an impression that the budget deficit will simply vanish into thin air by increased borrowing. The agreement is like giving pain killer to a cancer patient.
The global political situation is not helping either. Unrest in the Arab world means that Arab Governments will have to spend more money in social services and building industries. They will have fewer surpluses to invest in the US. The Chinese people are becoming restive. The Chinese Government will increasingly shift its focus from exports to stimulating domestic consumption. Fewer exports will lead to fewer surpluses and less money for investing in the US. Condition of Europe is more or less similar to that of the US. Europeans have little money to invest. It too is mired in debt. The US, therefore, is less likely to attract global inflow of funds. The outflow of funds may increase, however. The Pacific Investment Management Company is the biggest private holder of US Government Bonds. It has started selling these Bonds and has taken a decision to exit from these investments. It is likely that the same would be done by other investors. As a result there is a good chance that there will be a glut of Bonds in the market with few takers. It will be difficult for the US Government to raise monies from the debt market in this condition.
The problem of the US is that its products have become uncompetitive in the global market. The straightforward solution to this problem is to reduce the wages and standard of living of its people and make its goods competitive. I see no other way for the US to survive. The present agreement actually distracts from taking steps in this direction. It is spreading the message that taking more debt will somehow stabilise the situation when actually more debt will worsen the situation. I expect the US, along with Europe, to get mired into deeper problems as their ability to raise funds from the global money market erodes due to their unwillingness to face the stark economic reality. The loss of the West will be parallel to the rise of the East. Investors will find investing in China and India to be safer than in the US. The new world will be centred in Shanghai and Mumbai, not New York or London.
It is highly surprising that the US dollar is rising against the rupee despite its worsening economy. The opposite should have taken place. Weakness of the US economy should have led to the global investors selling the dollar and buying rupees. But we find that Foreign Institutional Investors are selling in the Indian stock markets and remitting money to their home. Indian economy is not getting pat on the back for growing at an impressive 7-8 per cent in this dismal global situation.
My assessment is that this strength of the dollar is a temporary phenomenon like the bright flame of the lamp before it dies. It seems that many western banks are in trouble. They have bought Bonds issued by the Greek Government which is likely to default. They need to raise cash immediately so that they do not collapse in the event of such a default. They are selling shares in India and also gold and silver to raise monies for this security. The selloff is not a vote of ‘no confidence’ in the Indian economy. The selloff is actually a vote of no confidence in their economy. They are selling shares in India just as the family sells its silver in times of distress. That does not mean that the silver is worthless. On the contrary it means that the silver is very valuable and holds its value even in the times of crisis. So also are the Indian shares held by foreign investors.
The problem is compounded by an all-round sense of insecurity. Global investors do not know where to park their money. The US Treasury Bonds as well as major French banks have been downgraded. No country or currency appears to be secure. In such a situation the tendency is to park funds in the US. When every currency is weak, it is better to hang on to the largest among them. This can be understood by an example. Say a country has been attacked by foreign invaders. People are running here and there for security. There are two ways to go. One is to run away from the war theatre into the safety of the forests. Other is to get into the fort and hope for victory. The present tendency to invest in the dollar despite its growing weakness is like rushing into the fort. Global investors are buying dollar in the hope that the currency will not collapse. We should not get distracted by this immediate rush for the dollars. The developed countries are fundamentally weak and they have no help coming. They have to decline. The present policy of borrowing more to meet their current expenditures will only make things worse for them.
More debt will not solve the world’s problems